Thinking again about inflation

Repeat after us: High food prices are a result of problems on the supply side. And you get one of the great and unquestioned assumptions of contemporary Indian economic policy.

This issue became all the more important after the new inflation numbers were out on Thursday. Prices galloped in December by 7.31% on a year-on-year basis. Prices of pulses and edible oils surged.

Illustration: Jayachandran / Mint

The data in the sixth report of the parliamentary standing committee on finance paints a picture of rising demand. For most food items of mass consumption—rice, wheat, pulses, sugar and edible oils—demand has outpaced supply from at least 2007-08.

Inflation in these goods can be dated with the first effects of the government’s social security programmes being felt on the ground. As early as 2007, trends showed that in states where there was higher expenditure on the National Rural Employment Guarantee Scheme (NREGS), higher inflation too was not far behind. Bihar, Madhya Pradesh, Orissa and Andhra Pradesh were cited as examples at that time.

This story can be sketched somewhat like this: Higher wages under NREGS make it attractive for workers in these labour-surplus states to stay home, instead of migrating to states such as Punjab and Maharashtra. With more money in hand, these workers chase food items that they could seldom afford before. Higher demand, in the face of near-constant supplies, leads to an increase in prices. This story is repeated over the years. Inflation becomes the stuff of newspaper stories. There are two ways out of this problem. One is to augment supply by imports. This is not a simple task. In the case of pulses, for example, not many countries produce pulses of the kind consumed in India. One solution to ease the problem would be to go in for genetically modified foods that have the potential to increase output dramatically.

Is there a role for monetary policy in this unfolding drama? There is. It should be remembered that NREGS and other welfare expenditure is not dependent on availability of money from banks. Nor is it affected by interest rate increases (the poor are unlikely to save money, given their low income). Most of this is politically committed expenditure by the Union government. Monetary policy is about maintaining price stability and keeping inflationary expectations in check. Inflation is now spilling into other sectors; therefore, it makes sense to tighten monetary policy in the coming months.

Will a tighter monetary policy hurt the poor? Tell us at views@livemint.com